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When is a director liable for debts of the company?

We are often asked by shareholders and directors whether they can be made liable for the debts of their limited company.

It is a long established pillar of English law

that a limited company has its own legal identity. This means that each limited company is its own “person” separate to its directors and shareholders. A limited company can enter into contracts, it can lease premises and bring proceedings in the English courts.

A company does not, of course, have its own mind. A company acts through its directors and directors of limited companies have duties to the company which are set out in legislation.

The liabilities of shareholders are limited to the amount payable for their shares.

Directors have obligations to creditors of the company and to the company itself. There are circumstances when a director may be held personally liable for debts of the company if a director has breached those obligations or taken steps to worsen the position of the company’s creditors.

The most common situation where this arises is when a company finds itself in financial difficulty. If liquidators are appointed, they will scrutinise transactions approved by directors to try to determine the cause of a company’s financial position.

There are a number of examples of things that a liquidator will consider, including;

  1. A director who authorises payments preferring one creditor over other creditors. This is often the case in situations where the director authorising the payments has an interest in the preferred creditor.

  2. A director who authorises the sale of an asset of the company at an undervalue so as to facilitate a quick sale. Usually, the director will promptly pay themselves with the proceeds of sale.

  3. An overdrawn director’s loan account will need to be repaid if a company is in financial difficulty. This is because the company has loaned a director money and it needs to be repaid to allow the company to meet its liabilities to creditors.

  4. If a director enters into a personal guarantee in relation to a particular transaction, for example, rent on a commercial property. If that rent cannot be paid by the company, the landlord can usually enforce the personal guarantee against the director’s personal assets.

  5. A director has a responsibility to ensure that a company ceases trading if it is insolvent. In those circumstances, if the director insists that the company continues to trade and becomes liable for debts to creditors that the director knows the company cannot pay, the director could be personally liable for the offence of wrongful trading.

In addition to the above, directors can find themselves in hot water if they do not act in accordance with their statutory duties as set out in the Companies Act 2006. These duties are the subject of another Sewell Law blog.

The seriousness of the above cannot be underestimated because if a director becomes personally liable for the debts of a limited company, the result could be the loss of assets and, ultimately, personal bankruptcy for the director. Usually this is accompanied by a period of disqualification as a director.

Sewell Law regularly advises its clients in relation to the duties and responsibilities of directors. We have solicitors with expertise in advising clients on the wrongdoing of co-directors.

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